Stop an EDD Audit of Your 1099s in its Tracks

How to navigate AB-5

Assembly Bill 5, which required companies to reclassify most independent contractors as employees, is hurting employees. California’s new AB-5 and Gig Workers Bill has employers concerned since it is unknown what EDD will do next. The bill that passed a few months back was already affecting business owners. Now more than ever, the effects are magnified due to the impact of COVID-19. Most recently, EDD requires all employers to review the classification of their workers resulting in many being relabeled as employees rather than independent contractors. This is where employers need to STOP what they are doing because there is another way to verify your contractor’s 1099 status. 

Evaluate the current status of your workers

Ensuring that all of your workers are classified correctly is one of the strongest ways to reduce your risk of an EDD audit. Worker misclassification causes a large portion of California EDD problems. It can be confusing for small business owners to accurately determine whether a worker is an employee (receiving a W-2) or an independent contractor (receiving 1099).

Employees are subject to the control, jurisdiction, and oversight of the company, but contractors typically perform specialized work or projects under a contract. Contractors also set their own hours and negotiate their own pay, and they have little oversight, guidance, or disciplinary action from you or your business. If you blur these lines and treat your independent contractors like your employees, EDD might consider this as participating in an employer-employee relationship.

If you are unsure whether someone who works for you is an employee or an independent contractor, consider the questions provided by the California Department of Labor Standards Enforcement (DLSE). The DLSE Classification Test asks questions such as: does the work require a special skill; how much control do you have over how the work is performed; who provides the materials or equipment necessary, and/or are the costs related to these materials reimbursed; how permanent is the relationship; and others that can help you make a clear distinction. You may also file Form SS-8 with the IRS to help determine the classification of your worker.

If your worker does not pass the ABC test

There are two immediate actions you can take as their employer. 

1. Classify them as a Full-Time employee OR
2. Change your work agreement in a way that allows them to pass the ABC test.

Navigating an Audit

If EDD finds that you owe an assessment, you have a right to appeal the results of the audit. To move forward with an appeal, you should seek the help of a professional tax attorney who understands the nuances of the appeals process and can represent your best interests. If you don’t feel confident handling your EDD audit alone, reach out to a tax attorney from the beginning — a professional with expertise in tax audits can help you navigate communicating with EDD and providing the required records to help the audit go as smoothly as possible.

The best prevention technique, of course, is to properly classify your workers in the first place. If you’re unsure of the correct category for some of your workers, IRS can assist with Form SS-8, designed to determine worker classification. Those workers who are not contractors (i.e., all W-2 employees) must have the proper income taxes and payroll taxes withheld and remitted. In the event of an audit, a professional tax attorney is your greatest ally. 

If you need help preparing for or navigating an audit from IRS or the state of California, contact our expert team at Milikowsky Tax Law.